Solaris Oilfield Infrastructure, Inc.
Q4 2018 Earnings Call Transcript

Published: 28 Feb 2019

[Operator:]

Good morning and welcome to the Solaris Fourth Quarter and Full-Year 2018 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Yvonne Fletcher, Senior Vice President, Finance and Investor Relations. Please go ahead.

[Yvonne Fletcher:]

Good morning and welcome to the Solaris Fourth Quarter and Full-Year 2018 Earnings Conference Call. I am joined today by our Chairman and CEO, Bill Zartler; our President and CFO, Kyle Ramachandran; and our Chief Operating Officer, Kelly Price. Before we begin, I'd like to remind you of our standard cautionary remarks regarding the forward-looking nature of some of the statements that we will make today. Such forward-looking statements may include comments regarding future financial results and reflect a number of known and unknown risks. Please refer to our press release issued yesterday along with other recent public filings with the Securities and Exchange Commission that outline those risks. I would also like to point out that our earnings release and today's conference call will contain discussion of non-GAAP financial measures which we believe can be useful in evaluating our performance. The presentation of this additional information should not be considered in isolation or as a substitute for results prepared in accordance with GAAP. Reconciliations to comparable GAAP measures are available in our earnings release. With that, I'll now turn the call over to our Chairman and CEO, Bill Zartler.

[Bill Zartler:]

Thank you, Yvonne, and welcome, everyone. 2018 was a transformative year for Solaris across a number of fronts. First, we significantly expanded our Mobile Proppant Management System offering. We began 2018 with only 77 Mobile Proppant Management Systems in the fleet, which represented a market presence about on par with our next largest competitor. During the year, we outgrew the competition and demonstrated to customers that Solaris' solutions can reliably increase completion efficiency and enhance wellsite safety. As a result, we ended the year with a leading share of around a third of the total market and a 160 Mobile Proppant Management Systems in the fleet. Second, we diversified our product offering. In 2018, we completed the construction of our facility in Kingfisher, Oklahoma and commenced transloading activity. In addition, we designed, manufactured, and introduced our new silo-based patent pending Mobile Chemical Management Systems to the market. Our Mobile Chemical System is a new product line for both Solaris and the industry, and represents additional growth potential for the company as we look to 2019. Finally, in 2018, we introduced our last mile proppant management service offering which we expect to grow in 2019. While many of our customers prefer to rent our systems simply for the benefits at the wellsite in their own supply chain, a segment of the market is looking for fully delivered solution that we expect to continue to service in 2019. The transformational business that we drove in 2018 is also evident in our financial results. Solaris' adjusted EBITDA was $123 million for 2018, an increase of over 200% versus the previous year. And our fourth quarter adjusted EBITDA of $34.9 million was up over a 100% year-over-year. During the fourth quarter, a combination of seasonal upstream budget spending declines and a reaction to commodity price volatility resulted in industry activity decline estimated to be over 10% versus the prior quarter. This market volatility manifested in our fourth quarter revenue days declining to 6% from third quarter and adjusted EBITDA decline of about 4%. During 2018, we also made several investments in new technology that we believe continue to enhance our offerings and keep us well ahead of the competition that will set the company up for continued growth in the company years. These investments not only include our new chemical management system but also included several step change improvements to our fleet and Mobile Proppant Systems that we believe not only furthers our differentiation but will help drive continued wellsite efficiency gains and improved safety for our customers. These improvements will be made across our rental fleets so that every customer that rents equipment from us will benefit. The first improvement we made was to automate how our system operates. With our new AutoHopper technology, we have integrated our systems controls with the frac operators' blender's control system to eliminate the need for the person that historically operated our system. By automating our system and eliminating the need for manual over site, we are now able to enclose the transition point for our system delivered sand in the frac company's hopper and eliminate additional person on the wellsite. We have deployed our AutoHopper technology across approximately 25% of our fleet today. And we expect a retrofit all of our systems with AutoHopper over the next 12 months. Additionally, we have begun to rollout our latest software offerings Solaris Lens. Solaris Lens replaces our historical PropView offering and provides insight beyond just proppant at the wellsite. We have integrated Solaris Lens with Railtronix and several third-party trucking applications to now deliver complete inventory tracking from mine to well head, a true vendor-to-blender supply chain management tool. Solaris Lens will also track chemical inventory levels and other metrics related to our chemical systems. This will provide real-time visibility that is not currently available in most traditional chemical handling equipment. With these automation and inventory monitoring upgrades, we were able to increase the value our customers receive with relatively flat pricing for 2019. We also continue to work on improving performance and reliability of our systems so that we can continue setting the bar for the highest reliability in the industry. During the fourth quarter, our Solaris caused nonproductive time in the wellsite was 61 hours out of over a 100,000 resulting in a downtime percentage of 0.06% of total operating hours. Our consistent reliability and uptime is key driver to our continued success. We have been able to achieve this uptime performance due to our reliable system design combined with extensive field service training and our footprint and culture of continuous improvement. Our most exciting new development in the fourth quarter was the delivery of our new Mobile Chemical Management Systems product line. For several years, customers have ask us to apply our engineering and manufacturing knowhow to develop better way to handle frac chemicals for today's hydraulic fracing operations. During 2018, we finalized the design of our chemical system. And in the fourth quarter, we built our first three systems. I am pleased to report that it is working great in the field. As planned, we had used initial customer field trials to make tweaks to our system design. And based on the early success of our first chemical system combined with a level of customer interest we are receiving, we are building seven additional systems in the first quarter which will bring our chemical fleet to 10 systems by the end of March. While we expect most of these of systems to go out to customers on a trial basis initially, we are now generating revenue from our initial launch at full revenue rate. In our Mobile Proppant Management business, we continue to see the same opportunities we laid out for you in the last quarterly call. The broader pervasive industry trends of switching to regional and local sand use manufacturing type completion developments continue to support demand for our solutions. And there are numerous company specific growth opportunities for Solaris that include both growing share with existing customers and winning new customers. Some of them have never tried our Solaris system. Due to the recent commodity price volatility and delay in operator setting budgets, Q1 is off to a slow start and there is some uncertainty around the ultimate size and trajectory of the completions market in 2019. Initial 2019 upstream budgets are pointing towards approximately 10% less spending than the industry saw in 2018. However, we expect completions activity to hold up better than overall budget would imply due to cost savings and efficiency gains within operator development plans. While we continue to see opportunities to place new proppant systems both with existing and new customers and also grow our new product lines, we will limit our capital spend on new proppant systems until we have a better visibility on earnings for a consistent return on incremental capital. Because we own our manufacturing, we can respond to the market fairly quickly and begin to build it again when that visibility returns. As a result, our range of capital spend this year will be flexible depending on market conditions. The combination of entering the year with significant market foothold, several new product introductions, and outlook for the reduced capital spending sets 2019 out for another transformative year, one where Solaris becomes a meaningful free cash flow generative company. Given our confidence in this free cash generation, we initiated a regular quarterly dividend of $0.10 per share in December of 2018. This dividend does not mean that the growth opportunity is over for Solaris, but the new product to commercialize in 2019 and other new products in the works will continue to invest growth capital in our business, where we believe we can earn a high return on that capital. However, given our business has reached critical enough mass, we are confident that we can both continue to grow the business and return capital to shareholders. With that, I will now turn over the call to Kyle.

[Kyle Ramachandran:]

Thank you, Bill, and welcome everyone. As highlighted by Bill's remarks, 2018 was an exciting year for Solaris. We generated significant growth in our financial results highlighted by 40,526 revenue days, $197 million of revenue and adjusted EBIDTA of $123 million. Revenue days and revenue were all up over 100% and adjusted EBIDTA was up 209% compared to the policy. During the fourth quarter, our financial results were impacted by well documented slowdown in industry activity with the one-third market share in wellsite in profit handling we are not immune to changes in overall market activity. However, we outperformed the market in the fourth quarter generated 11,115 revenue days, $57 million of revenue and adjusted EBIDTA of approximately $35 million, revenue days decreased 6% sequentially against the backdrop of the completions market that we estimate was down over 10%. Revenue was up slightly due to a full quarter contribution of operations at our kingfisher transload facility. Adjusted EBIDTA declined 4% sequentially due to lower revenue from fewer revenue days and higher service costs as we maintained our service technicians staffing levels to cross-train on our new chemical systems. Gross profit defined as total revenue less the cost of system proppant system rental and services, transloading services and inventory software services, excluding depreciation and amortization expense, declined 4% to approximately $38 million compared to $40 million in the third quarter, primarily due to lower revenues and operating activity combined with slightly higher service costs. Selling, general and administrative costs and salaries, benefits and payroll taxes increased 6% sequentially to $4.1 million. Going forward, we expect total SG&A and [indiscernible] run rate closer to $5 million per quarter. Net income for the quarter was $24.7 million, a decrease of approximately 6% versus to the third quarter. Net income for the full year was $86 million, an increase of 280% versus the prior year. Adjusted pro forma net income for the fourth quarter was $21.6 million or $0.45 per share versus $24 million or $0.51 per share in the third quarter. Adjusted pro forma net income for the full year was $79.6 million of $1.69 per share versus $21.1 million or $0.48 per share in 2017. Our presentation of adjusted pro forma net income adjusts for certain items that we believe are non-recurring and also assumes the full exchange of all outstanding LLC units and Class B shares not held by Solaris Inc. for Class A shares. By assuming the full exchange of all outstanding Class B shares and Solaris LLC units, we've presented net income and earnings per share that is more comparative with other companies that have different organizational and tax structures. Total capital expenditures for the quarter were approximately $36 million, which was down from third quarter as expected due to the slowing manufacturing rate of our new proppant systems. During the fourth quarter we added 14 proppant systems and three chemical systems to our fleet, for the full year we deployed approximately $160 million into the business adding 84 proppant systems and three chemical systems to our fleet, in addition to completing construction of our kingfisher transloading facility in Oklahoma. I will now turn to our outlook and capital spending for 2019. We ended the year with 160 proppant and three chemical systems in the fleet in line with prior guidance. Due to the slow start and completions activity in Q1 and the uncertainty around operator spending pace for 2019, we've elected to pause building additional proppant systems not currently in our queue until there is better clarity and demand. We have significantly reduced our prior outsourcing efforts and are reallocating our internal manufacturing resources to building out our chemical system fleet. In general, it takes us about a quarter to start or stop building, so they are few instances and progress that will be completed in the next couple of quarters. Given our early success with our initial chemical systems, we have decided to build seven more in Q1. We expect to end the first quarter with 163 sand systems and 10 chemical systems. As Bill also mentioned, we expect most of these chemical systems to go to customers initially as field trial but our first chemical unit has transitioned into a full revenue rate which adds to our confidence in the commercial opportunity of its new product line. We expect to use operating cash flow to fund our capital needs in 2019, we currently forecast 2019 capital spending in the range of $40 million to $60 million, this is down considerably from the approximately $160 million we spent in 2018 and approximately $100 we deployed and 2017 as we built out our fleet of Mobile Proppant Management as well as our Kingfisher facility. If 2019 turns out to be a slower completions activity year then bottom of the range represents not building any additional proppant systems beyond the current queue, a smaller number of chemical and non-pneumatic systems continue rollout of our other harbor technology and other corporate capital expenditures. The upper end of the range would represent a stronger market and an increase in the number of proppant, chemical and non-pneumatic kits built. Because we control our own manufacturing, our ability to flex up or down to react to market demand can relatively quickly, so we think this range is an appropriate way to think about 2019 CapEx given the current market uncertainties. We ended 2018 with approximately $82 million of liquidity which consisted of $25 million of cash and $57 million of borrowings under our credit facility, subsequent to year-end we repaid the $13 million that was drawn under the facility at year-end and today we have nothing drawn on our credit facility. Turning to our outlook for Q1 as Bill mentioned Q1 got off to a slow start as many other services companies have already discussed. We have seen a pick-up in activity from January levels and expect another pick-up in activity in March, which on a net basis we forecast will result in roughly 5% decline and the average number of proppant systems rented for Q1 relative to Q4. One modeling note I would like to make relates to our amended contract at Kingfisher, as part of the amendment we received approximately $26 million of cash in December, the appropriate accounting treatment dictates that we recognize the $26 million payment as deferred revenue which will be recognized over the remaining life of the contract. In other words, you should expect approximately $3 million of deferred revenue to be recognized each quarter starting with the first quarter of 2019 through the fourth quarter of 2020. I would like to wrap up my remarks by talking about cash flow, with the adjusted EBIDTA in the fourth quarter of approximately $35 million and CapEx of approximately $36 million we were another step closer to breakeven free cash flow before changes in working capital, we believe the inflection and positive free cash flow will occur in the first quarter and we expect meaningful free cash flow generation in 2019. In December 2018, we initiated a regular quarterly dividend of $0.10 per share which combined with our CapEx plans we expect will be primary uses of cash in 2019 given that we have no debt on the balance sheet. We remain committed to deploying any excess cash, where we think we can generate the highest rates of return for our shareholders. With that, we would be happy to take your questions.

[Operator:]

We will now begin the question-and-answer session [Operator Instructions] The first question will come Martin Malloy with Johnson Rice.

[Martin Malloy:]

Good morning.

[Bill Zartler:]

Good morning.

[Kyle Ramachandran:]

Good morning, Marty.

[Martin Malloy:]

I was wondering if you might help us with the implied free cash flow range for '19. If we just take the midpoint of your CapEx, can you give us some idea of just how much free cash flow you might be generating?

[Kyle Ramachandran:]

Hey, Marty. I think at this point we've given the guidance, our capital, we've given guidance around what the end of the quarter looks from a system deployment; we haven't gone as far as describing EBIDTA or cash flow from operations if you will. If we look back at last year it's a good indicator of the baseline. I think we've got that added wedge of chemicals coming in, but we also if you look at the fourth quarter versus, say, the first quarter and we increased our fleet pretty significantly. So if we think about fourth quarter moving forward, we got opportunities to deploy more systems, which will obviously generate additional operating cash flow, but at this point from a free cash flow range for the year, we are not going to get too prescriptive there, but I think what's critical is we are coming out and being very clear around capital spending this year will be down significantly from where it has been in the last two years.

[Martin Malloy:]

Okay. And then recently one of your competitors who has done a proppant storage offering came out on their call and talked about gaining market share. It doesn't appear that you all are losing market share, but maybe if you could spend a moment talking about some of the competitive dynamics out there on the proppant side?

[Bill Zartler:]

Yes, thanks Marty. I mean it's been a competitive market for years, and we continue to see competitors and our customers and various other customers, operators trying different systems, and we believe we have a solution that continues to win the whole market share, and even grow market share. So there's a lot of infighting among the other competitors and lots of litigation going on, and we're staying out of the fray and trying to build a system that is highly reliable and gives our customers what they want.

[Martin Malloy:]

Great, thank you. I'll get back in queue.

[Operator:]

The next question will come from Jud Bailey of Wells Fargo.

[Jud Bailey:]

Thanks. Good morning. I wonder if I could get your thoughts on what you're seeing from a pricing perspective. Obviously, with more competitors, I'd be curious if you could share your thoughts on how kind of rental rates have kind of played out as you renegotiated pricing for 2019?

[Kyle Ramachandran:]

Sure. I think really in Q4, we're effectively flat quarter-over-quarter, which is how we indicated we expected the quarter to come out. When we look at 2019, you may come around more competitors. I'm not sure there's more. There's more capital maybe being deployed by other competitors, but those competitors have been out there for a while. The relative merits of different offerings are pretty well understood. When we looked at 2019 pricing, we actually looked at what can we do in 2019 to improve our offering to our customers. And there's several things we've done, the most notable being the AutoHopper system we are rolling out across our fleet. This is going to eliminate multiple people from the wellsite for our customers. So that's real value that we can ascribe to our customers while keeping pricing flat. I think Bill mentioned in his prepared remarks, we look at 2019 pricing and the negotiations we've had with our customers, for the most part, pricing is flat, but value proposition is going up. So it's all hopper. And then also the [indiscernible] made in the call as well. There's more to that, and I think we touched on, but this is now encapsulating [indiscernible] supply chain visibility, which really hasn't been done yet. There's been different components that one could piecemeal together, but we now have put it in a manner that our customers can look at one app on their mobile devices to see that full visibility. And that all comes with their rental rates, which are flat year-over-year. So, one way of saying pricing is flat for us, not sure how the competitors are out there, we do see them trying to compete on pricing, BUT when our customers do the full math, it's not about necessarily the headline rate of our equipment, it's about the total delivered cost of sale into their blender and the total cost of their completion. So if they're down for NPT or any other challenges that other equipment they have that actually nets out to a much higher all-in cost.

[Jud Bailey:]

Okay, all right, I appreciate the color to that answer, Kyle. Could you maybe talk a little bit more about the chemical silos? And you'll have 10 by the end of the first quarter, are all of those accounted for by customers or you building them for more trials, or how much revenue do you do expect to take out from the incremental sand, or excuse me, chemical silos this quarter?

[Kyle Ramachandran:]

Yes. This is uncharted territory for the industry. It's certainly uncharted territory for us, but the feedback so far has been incredibly robust. We're completely changing the way people are managing chemicals on site. And historically, you've got walkie-talkies, and you've got dozens of folks running around, opening up different valves and different tanks, depending on what people are seeing down hall. When we look at what we've been able to do today, we now have somebody in the data band precisely dosing how much friction reducer, how much asset, how much biocide is going down whole, so we completely transformed that concept. And so, it's not going to be overnight that people are going to jump into this. This is an industry that has a certain pace of adopting innovation, but the feedback from a very large group of folks today has been very compelling that has allowed us to get comfortable with building out in seven additional systems. So, are they exactly spoken for in a precise manner? Not necessarily, but the queue is longer than the seven that we're building, I guess is one way to frame it.

[Jud Bailey:]

Okay, all right. I'll turn it back. Thank you.

[Operator:]

The next question will be from John Watson with Simmons & Company.

[John Watson:]

Thank you. Good morning.

[Bill Zartler:]

Good morning John.

[Kyle Ramachandran:]

Good morning John.

[John Watson:]

Kyle, I think I heard you right on the guidance for number of profit systems deployed down five on average quarter-over-quarter, but it sounds like completions activity is expected to improve throughout the quarter. Should we think about your March number systems deployed being higher than January, just trying to get a full picture for what that number looks like for the quarter?

[Kyle Ramachandran:]

Yes, that's right. I think the way we described it was February is ahead of January and March looks to be ahead of February. So we're starting to build momentum back up into the queue. As we saw into the end of the fourth quarter, we didn't necessarily have quite as big of a drop off as others. We had folks keep systems online expecting to add frac crews, not all those frac crews have been added. And so, our customers have reacted in that manner.

[John Watson:]

Okay, perfect. And then Bill mentioned the fully delivered system, can you speak to how many of those might be deployed in the first quarter and what percentage of your systems might be a fully delivered offering? And then, is there any change in profitability that we should be thinking about for those systems versus your legacy offering within proppant?

[Bill Zartler:]

I think it's still from a relative percentage of our fleet, pretty nascent, it's a small percentage, but we think that growing percentage is a growing percentage. When we look at the RQ, RQs that we're analyzing, or the different proposals we're putting together we're seeing more of those as an overall percentage of new business opportunity, and then when we look at the margin profile, you're spot on, it's likely going to increase our contribution margin from a nominal perspective. But on a margin percentage basis, we would expect to see margins comedown. And the reason for that is last mile we're talking about procuring trucking and then passing that on to our customers in a structured manner in a way where our revenues will be a lot higher, but our costs will be a lot higher. But on a net basis, we expect to see more dollars of contribution margin than we would otherwise for providing that incremental service. And I think importantly, one of the ways we can couple ways we can differentiate on that, sleds lens allows us to really drive down those trucking costs and drive efficiencies by being able to manage the volatility inherent in moving 400 to 500 truckloads per well. And then, secondly, we do believe our system provides the most flexibility and unloading trucks and moving them off the wellsite quickly by having multiple unloading points that can be done in parallel.

[John Watson:]

All right. Okay, makes sense. And then lastly, for the typical systems I know you don't have an exact breakdown as who the customers are, but can you speak broadly about renting to EMPs versus pressure pumpers versus chemical companies?

[Bill Zartler:]

I think in the tenant it'll be all three into your point in terms of exact numbers around who is going to be the bigger component, what I'll say is the operators really are excited about it, but a lot of them need some explanation some help around how this is actually going to work. So the integration with chemical companies is going to be paramount for us to continue to build this out.

[John Watson:]

Okay, perfect. Thanks, guys. I'll turn it back.

[Operator:]

The next question will be from George O'Leary of Tudor, Pickering, Holt & Company.

[George O'Leary:]

Good morning, Bill. Good morning, Kyle.

[Bill Zartler:]

Good morning, George.

[George O'Leary:]

I don't have - as well as interesting, I remember back around that the IPO you guys have talked about bringing that service person ratio down from one-to-one person to system and maybe making those two systems for one service person. Do the AutoHopper help bridge that gap and get you guys there or could you adjust that ratio even further?

[Bill Zartler:]

AutoHopper a little bit, but if you recall, our personnel aren't the ones actually operating it on the wellsites it's our customers that operator or our customer's frac operator runs it. So what we've done is given another additional value proposition to our customers by eliminating the person that was running the sand system, you can now combine that with the one running the blender. So with the control system for the silos integrated to the blender controls, you've eliminated the need for an independent sand handling individual on the wellsite. So that's really a value proposition more for our customers on the like. We clearly see and have kept personnel a little higher than we may have anticipated relative to needing one person for every two systems. We've sort of kept it one-to-one and a little higher in the fourth quarter as we recognized the need to really get additional people trained on the chemical silo. It's a little more complicated than the same silo. You've got five different containers of it. You've got pumps that you're running, you've got a - it's a little more complex and so we've spent a little bit of operating expense to make sure that we've got the individuals trained at the high level of service that we want to provide the customers with all the troubleshooting and all the needs that we have for that system.

[George O'Leary:]

That's super helpful, and then as you guys have taken more of the manufacturing in-house, can you speak to maybe just in percentage terms the ability to lower the cost of your system or how much less did it cost you to build the system today than it did - than it cost you 18 months ago?

[Bill Zartler:]

The learning curve is real. I mean we've made 116 sets of 6 silos, so that we've made a lot of kit over the last two years. And so I think we started, we're probably 30% to 40% lower than when we started. Steel prices have been up but that's a minor component as we've grown it. The outsourcing pieces we acknowledge was more expensive to have other people some self-assemble for us. That is now out of the system as we slow down the manufacturing pace and brought pretty much everything back in-house today from manufacturing perspective. So the cost of a chemical system will be approximately half of that of a sand system and our cost as opposed to with third-party components built into it.

[George O'Leary:]

One more if I could, just to make sure I understood right. Kyle, I think you said five less systems active in Q1 or system, but I'm just curious just from a revenue days perspective, what do you think that maybe translates to quarter-over-quarter?

[Kyle Ramachandran:]

Well, what other challenges we're seeing in our reporting of revenue days is we create our own volatility by their being just different amount of actual days quarter-over-quarter. So we're trying to migrate more towards sort of concept of six pack equivalent because the other challenge we have is with chem silo is coming in, we can talk about revenue days where chem silo and sand system together but the challenges of course the revenue for each of those revenue base is different. So, I think as we look forward those are probably going to be migrating towards talking about six pack equivalents. So I think that the 5% was sort of in the notion of around the number of six pack deployed.

[Operator:]

The next question will be from David Smith of Heikkinen Energy Advisors.

[David Smith:]

I think your first chemical system went to the field, was that in December?

[Bill Zartler:]

Correct, yes.

[David Smith:]

And now you're looking to have sand systems at the end of March? Wanted to ask if you think Q1 represents a reasonable cadence for the rest of the year or if it's too early to say? Maybe I should ask more specifically if you can talk about how many chem. systems might be contemplated and the low versus high range of CapEx guidance.

[Bill Zartler:]

Let me start with - we haven't determined how many we're going to make. We're really watching the market really closely and have that flexibility built in. As we've said before, chemical system capital cost average is just under $1 million or so - $850,000, $900,000 and so, we can increment at those levels based on demand and so I think we've got infinite flexibility. The low end of the range as Kyle mentioned is effectively shutting down manufacturing of the profit systems and maintaining the 163 systems that will have at the end of first quarter, and maintaining that level until we see the need to make more, and so that sort of ends up in the lower end of the band. The higher end clearly if the chemical systems adoption goes like it could, we will be turning up our internal manufacturing on that for that incremental, call it to the $20 million number that the range has in it.

[David Smith:]

And just wanted to double-check something; with regard to the Q1 guidance of - let's call it six pack equivalent revenue days. I thought I heard down 5% in Q1? But I've also been hearing the down 5 systems. I just wanted to double-check and make sure I got that right.

[Kyle Ramachandran:]

It is right. It's 5%. I mean just to kind of provide some context here, the number of systems utilized in a period is the most conservative way we're going to look at this. When we look at different companies in this space, utilization is very loosely defined term. We use the most conservative method which is the actual number of days, systems that are generating revenue. But when we look back at Q4 and the implied utilized systems about 121 at varying points we have as many as 140 working. And so I think in order to service 121, we're going to need more than the 121 in the fleet. So, I think as the business continues to evolve, that's just going to be a function of not being 100% utilization as we get more and more of the market.

[Operator:]

The next question will come from Stephen Gengaro of Stifel. Please go ahead.

[Stephen Gengaro:]

Thanks, good morning.

[Bill Zartler:]

Good morning.

[Stephen Gengaro:]

So, two questions if you don't mind; the first is, have you seen any change in the dynamics around 12 packs with the obvious enormous rise in basin sand, what's that dynamic been like over the last quarter or two?

[Bill Zartler:]

It's still very, very fluid. We've seen cases where we've had four, five or six, and six at one time and four, five. And we've seen times when we've had two or three. It really - it ends up being fluid. I think the notional move to in-basin sand and the volatility of trucking across the basin especially if you look at the Western Delaware basin from the local sand mines on the Eastern side of Delaware basin, that's a pretty long-haul, there's a lot of volatility there. So we've seen those markets geared toward 12 pack, and I think it's a much better solution than trying to do intermediate storage at locations. If you've got enough at wellsites and enough wellsites, you can keep sand flowing out of the mines as regular as possible into the wellsite. So it's still a fluid item, but we haven't seen a massive switch toward 12 packs because our system is so efficient with 6 that we can unload nearly 24 trucks at a time and hold enough inventory to keep most frac supplied on a regular basis but we still see some and we still see a few that really do like the additional storage capacity on the wellsite.

[Kyle Ramachandran:]

And I think the other point there may be on the trucking side and the local mines [indiscernible] is created, just the challenges around them being for longer distances in a truck. So with the transload you can typically get them closer to your wellsite the mines to those points tend to be a longer pole. And so for every pound of sand you don't carry, it's in a solution that doesn't have that higher payload, you do create challenges at the wellsite. So because our systems are able to use industry standard pneumatics as well as belly dump trucks, we're able to more sand per truckload than maybe some of the container solutions. And so, I think as far as the impacts of the local sand that is one of the challenges that we see for the other solutions.

[Stephen Gengaro:]

And just as a second question, when you talk to customers now and obviously I know there's been competitive offerings out there in general. But have you lost to your knowledge any meaningful - been replaced on site by any other vertical solutions or is this really just a near term activity issue that's causing the lower utilization? Can you speak to those dynamics a bit?

[Kyle Ramachandran:]

Well, I think the reality is we have very smart customers and they get called on by lots of different customer or other competing solutions that are offering different race, different economic propositions, whether it be fully delivered solution versus a rental model. And so, our customers are savvy and they're going to try everything. Our largest customer typically will go through a process every year where they give everyone also a fair shot at winning work. And it's our job to continue to innovate and drive additional value as referred to earlier to our customers to ensure that they are happy. That's our job.

[Bill Zartler:]

Yes, and I think there is lots of movement around, I think we don't see we've lost any meaningful. There're places where we can say we may have lost the customer here temporarily and there are spaces where we know we won a customer temporary. I think we continue to believe that we can keep growing our market share with the offering and with the evolution of our equipment.

[Kyle Ramachandran:]

And as we see the intensity on wells go up, multifaceted, so more wells per pad, longer laterals, more tons per foot, we do see customers, operators coming to us who have gone with other solutions and they're coming to us and saying we're running out of fuel on locations. We just can't keep up with the other solutions. The beauty of 2.5 million pounds available at the blender if just completely remove the challenges associating with delivering hand to the blender, it's already there, it's controlled today by the speed of the blender consuming saying it's no longer even controlled by us deliver extended to the blender. The blender is really pulling sand directly into its hopper.

[Stephen Gengaro:]

Okay, great. Thank you, thanks for the color.

[Operator:]

The next question is from John Hunter with Cowen.

[John Hunter:]

Thank you. Good morning. So I wanted to ask on gross margin dollars as we had from 4Q to 1Q. You mentioned some of the costs that were elevated in the fourth quarter I'm wondering if those costs to go away in the first quarter so that we could see gross profit up slightly in the first quarter and that's obviously with the understanding that activity will be down 5%?

[Kyle Ramachandran:]

I'm going to break that down a couple ways. Our most important costs in our cost structure on direct basis is personal. We talk about the importance of our people and say we've got a 150 plus field technicians scattered throughout the country and there are frontline then face to our customers wellsites, and so those guys are really important to the success of this business. So that's the biggest piece of it in the fourth quarter we really did not move that head count around despite a drop off in activity and we don't expect to do the same in the first quarter. We got visibility into activity growing, we've got a new product being launched that were cross trading as well as growth in that new product. The other piece that I will touch on is we talked a little bit about last mile. We did have a last mile those pretty material in the fourth quarter and that created more dollars of costs but there's also more dollars of revenue associated with that.

[John Hunter:]

Got it. Okay. And then one on their chemical offering just thinking about the margin that you can earn on those systems over time, I think in the past we've talked about the margin being about half of what your legacy proppant system could earn. So as you've converted some of these initial customers to full revenue is that kind of the same range of margin you're expecting going forward or is that changed at all?

[Kyle Ramachandran:]

I don't think there's any update there, the early days of this were require some more personnel onsite from our perspective. So that likely drive some lower relative margins but over the long run now I think expected to be very comfortable?

[John Hunter:]

Got it. Okay, and last one for me is how many belly dump systems do you have in the suite currently I think last update was around four and have you seen increased demand from customers for these types of systems giving the faster on unload times. And then last part of the question is just is there any way you can reconfigure how the upload process works at the wellsite so that you could dump more than one or two at a time? Thank you.

[Kyle Ramachandran:]

Sure. There's [Indiscernible] we will try and get all that. We've added a couple of the non-pneumatics to the fleet or continue to build a couple of those additional and remainder of the quarter as well. The fundamental concept is operators want to ensure couple of things. They want to ensure there's always sand available at the blunder they don't want to run out and they want the lowest cost delivered to the wellsite. So whether it's a Belly Dump Solution or pneumatic solution or box solution, what's driving all this is? What's the lowest cost option? And so we've got fair amount of initiative around driving down trucking costs on the pneumatic side, through multiple lever, that allow us to get the very similar economics as what you'd see at the Belly Dump. And that is the concept of on the spreadsheet I can unload the truck faster or it may be able to pull more sand in Belly Dump truck is interesting but it doesn't tell the whole story. The key to success in our opinion here is reliability, when you start introducing these unloading mechanisms around belly dumps you do create single points of failure. We will raise our hands and say our belly dump solution has a single point just like all the other belly dump solutions out there, but what we benefit from as we can unload pneumatic trucks in parallel and we've done that in the deployment of our belly dump solution. The belly dump is typically used in conjunction with pneumatic. We can run it completely with the belly dump but the pneumatic flexibility just gives you added insurance, if you will.

[Bill Zartler:]

All right. That's right cover.

[Kyle Ramachandran:]

It's all that, I covered it all, John.

[John Hunter:]

Yes, I know that makes a lot of sense, and Kyle, thanks for answering the questions.

[Operator:]

The next question comes from Jason Wangler with Imperial Capital.

[Jason Wangler:]

Good morning. I was curious as you kind of ship the manufacturing to two different systems up to the chemical and the sand, Kind of how do you think your capacity looks. I guess just what you're doing in the first quarter or in general as you think about and what would be full capacity or what you guys could do in the chemicals. Is kind of started ramp up?

[Bill Zartler:]

Well, we noticed and look at the capacity of our plant without significant work outsourcing at four to five, six packs on a monthly basis. And you consider chemical silos about half of that or maybe at 65% of that because there's some additional fixed components of that. So the capacity at any kind of reasonable pace was not an issue for us in house and our manufacturing.

[Jason Wangler:]

Okay. I'm just curious as you think about the CapEx budget and then obviously should be generating free cash flow. How do you think about deploying that I mean even you hit the high end of the range I think they're still be some pretty significant cash flows will grow the dividend or any other things you guys kind of look at s you look forward?

[Bill Zartler:]

As we said repeatedly we're shareholders and we are focused on making the right decision around what we do with the cash we instituted the dividend in the fourth quarter and we've continually evaluated whether share buybacks makes sense. We've looked at an opportunistic M&A activity and to this point we have tried to maintain as much flexibility we have on behalf of our shareholders as possible.

[Jason Wangler:]

I appreciate it. Thank you.

[Operator:]

The next question will be from Scott Schneeberger of Oppenheimer. Please go ahead.

[Scott Schneeberger:]

Thanks, good morning, Kyle you mentioned some discussion of margin I'm just curious thinking on longer term with a retro fitting I assume that so if there's CapEx impact that's baked into that number that you talked about but how should we think about OpEx over a longer term with that activity and then kind of a follow-on. How about repair and maintenance as far as impact margins up?

[Kyle Ramachandran:]

I think you're afraid a retrofitting around potentially AutoHopper being installed in the rest of our systems, yes, you're right. That's a piece of capital so that really shouldn't have any impact on margins and I'll back in our biggest cost volume today is field supervision I think we have done a really good job of keeping great people training them making a great place for them to work and giving them a great career opportunity. So I thing we've been able to manage the field costs from that perspective. As far as maintenance it's clear we got a relatively young fleet, our oldest system is been running in the field six years without any major overhaul. It's probably time for a few of those to come back in will be cautious with the spent on that. We want to deploy the capital in other words until we're ready to deploy that system to the field but as we look out over the next five years they'll be some sort of maintenance cycle where we do bring things to get refurbed but notionally I don't think it's material to the overall cash flow profile.

[Scott Schneeberger:]

Thanks and then as a follow-up just on the chemical management systems. Sounded like a one that at full revenue run rate and three out on in the fleet at the end of the year and then anticipating 10 at the end of the first quarter. Any incremental color you can provide on would those incremental speed up in a full revenue run rate how should we think about that? Thank you.

[Bill Zartler:]

Sure, Scott. I think there's a these couple of things that the customers that have gone through their trial period, yes incremental systems would resulted an incremental revenue out of the gate. But we were also trying to manage is, trying to get as many of these and do as many different customers as possible. We're taking a long term outlook here. And what's the market opportunity for us and how quickly can we get visibility into capturing a larger piece of that pie rather than filling our first customer with as many systems as they want.

[Scott Schneeberger:]

All right, thanks very much. I appreciate it.

[Bill Zartler:]

Thanks.

[Operator:]

The next question will be from Mike Urban of Seaport Global.

[Mike Urban:]

Thanks, good morning.

[Bill Zartler:]

Good morning.

[Mike Urban:]

So, I completely agree with the view to be disciplined on the CapEx front so you have some better clarity. I guess the question would be what if your competitors are not? In fact, it seems like they kind of aren't right now and they're going full speed ahead with systems deployment. So you guys have clearly laid out your value prop and of the ability to deliver a lower cost to customers. But if you start to see that share position slipping, do you react to that as there is some kind of balance there between kind of achieving strong returns has always been your focus and kind of maintaining or growing that share position? And I guess just the bottom line is how do you react to market for your competitors rather kind of get more aggressive on the share front?

[Bill Zartler:]

There's been overcapacity in this market for the last three years. So, this is not a new phenomenon. I think there are folks talking about going after - there's higher operating cost and then there's a point at which because of our really light operating cost relative to our current return profile, they're losing money if they cut much. And we've held pretty firm on pricing. We have a set of customers that look at the full package and the full numbers including the reliability and the cost of downtime and embedded within our system is really an insurance policy that is - it comes along one that is free. And so I think we continue to focus with our customers on a long-term relationship basis with we're helping them be much more reliable, were bringing them new tools and new tweaks to the systems that they ask for and we're rolling it out to people that haven't asked for it yet. So I think our edge and our competitive edge is being there as a true value proposition and getting into a knife fight with somebody that's going to lose money is not something that we're going to do. And I think we're focused on delivering something and having a set of customers that actually see the whole picture. And that means that there are some customers who won't have. I think that that is still - there is still market share beyond we have today to continue to gain with customers that actually look at the whole picture. We mentioned the addition of sort of the re-bundling if you will of the delivery the whole last mile. I think that there is a bit of a trend and that also allows a little more of an apples-to-apples comparison on things, which I think is actually very helpful for us to go in and continue to do that as the market is unbundled between the delivery piece and the wellsite piece, and then there's a few customers that will never re-bundle it and do their own thing. And then there's a few that are asking for the package to be put together which is what we're doing for them and I see some growth in that over the course of the next year.

[Mike Urban:]

And speaking of the bundling, as you rollout the chemical systems; is that still at a point where it's - I guess not really kind of a bait I guess you have a commercial model at this point, but you're just trying to kind of prove up the system itself, have you seen any interest in bundling the chemical system with the rest of the offerings?

[Bill Zartler:]

As far as addition - bundling it with chemicals?

[Mike Urban:]

Yes, bundling the chemical systems in with the rest of your offerings.

[Bill Zartler:]

No, with offers, yes, absolutely. No, I think people are seeing this is the way to automate their frac to reduce personal footprint to improve HSC and to drive down costs. So, no, I think the idea of having 9,000 location is exactly right. There are synergies. So by putting out our chem system, you significantly reduce the footprint traditionally associated with chemicals. And that's actually going to allow you likely to deliver more sand trucks because you've got more - you've got a bigger footprint. So I think there're complements with it.

[Kyle Ramachandran:]

And I think the addition to that is the Solaris Lens technology. The full integration of sand supply chain and chemical supply chain for one supply individual at the operator or at the frac company is a significant benefit to allow them to really better manage the supply. And I think ultimately the game for our ultimate customer, the operator, is to get very efficient at making oil and gas. And as they get more efficient in their fractioning operations and plan better and do it that way, this is a tremendous tool that gets package together very, very effectively with the use of the software as well.

[Mike Urban:]

Great, that's all from me, thank you.

[Operator:]

The next question comes from Praveen Narra of Raymond James.

[Praveen Narra:]

Hi. Good morning, guys. I just wanted to follow-up on John's question earlier just in terms of the January to March, I guess if we could just clarify, is March much higher than the 4Q average for sand systems out?

[Kyle Ramachandran:]

I'd say it's probably pretty close to inline.

[Praveen Narra:]

And so understanding that it's a little bit of a different dynamic going into 2019 than it was going into 2018, but when we're going to 2018, we talked a lot about guys signing contracts for the year. Can you talk about how that has progressed or is this year likely more of a spot year or how do we think about it?

[Kyle Ramachandran:]

That's great point. We probably didn't mention - we kind of took it for granted internally, but we went through the same process we did last year. We sat down with one of our customers in the fourth quarter beginning of the first quarter, we talked to their plans for the year, we talked to the value proposition we believe we're delivering this year. And so in agreeing to placing, there was an agreement to some sort of minimum number of systems by the vast majority of our customers. So it's the same dynamic that we had last year. As we said last year, the minimum volumes are set below where people are today. But there is a base load inherent in what we have.

[Praveen Narra:]

And I guess just to your earlier point, I assume than the pricing number is flat for those contracts generally given what you guys talked about is your viewpoint?

[Kyle Ramachandran:]

Correct. We expect the price will be flat this year.

[Praveen Narra:]

And then last one from me on the chemical silos, when we think about the test phase for the customers that have gone through it, you mentioned one getting up. Can you talk about the length of time it took to get from trial to revenue and if you could how many customers have actually gone through some sort of trial thus far?

[Bill Zartler:]

I think in terms of the specifics of our commercial agreement around the trial. I don't want to get into that, but there're multiple customers that are indicative, there's multiple that are using them and we feel very good about the visibility.

[Operator:]

The next question will come from Samantha Hoh of Evercore. Please go ahead.

[Samantha Hoh:]

Hey, thanks for taking my call. So quick question just to stay on the chem systems, and I think all of the trials have taken place in the Permian, but is there any discussions with customers about potentially doing trials outside of the Permian? And then longer term is there any reasons why the overall adoption and rollout would be similar to your proppant systems?

[Bill Zartler:]

I will take the first part, actually in reality we've actually been in multiple basins. We got interest in a lot of basins for different reasons. We look in the Northeast as we've mentioned footprint and the chemical side is a big challenge. And so this cleans up a significant portion of footprint and a lot of these pads in the Northeast are very tight. And then we're actually moving into the DJ basin. We've never had one of our sand systems in the DJ basin but we expect to have our chem system in the DJ basin shortly. So it's actually a new market for us, while we have grown pretty significantly in the Rockies broadly. On the sand side, we've actually not been in the DJ basin. So, I think from an opportunity perspective there's nothing inherent to the Permian versus any other basin that was within our opportunity.

[Kyle Ramachandran:]

I had one more point, we were asked to move one of the early chemical systems up to the Northeast and much with the weather and so we better wait until it warms a little bit for the new fluids into an area where you saw the polar vortex and things look at it. So we will see more movement out there over the next couple of months as things fall out.

[Bill Zartler:]

As you think about launching new products, you want to give yourself the highest chance to success early on and no doubt we will be addressing the inherent challenges with cold weather, but as far as the first couple getting out there, we want to make sure we didn't create another challenge for ourselves.

[Operator:]

The next question is a follow-up from Martin Malloy of Johnson Rice.

[Martin Malloy:]

Just one follow-up, some of the integrators have recently talked about some pretty robust spending programs in the Permian going out five- plus years. Could you maybe talk about the inroads that you've made with some of those integrators? And I seem to remember that some of them had some arrangements with maybe some of your competitors that might be rolling off over the next year or two?

[Bill Zartler:]

There is some of that, there're some of the other big integrators who work closing with our customers, and so, we're on many of those wellsites through our good friends in Midland. And so, I think we see this as a great solution for them as they roll out really heavy activity and heavy manufacturing mode and some blocky acres [indiscernible]. I think I got a picture from East of Carlsbad a couple of days ago that had three different sets of silos in one picture from a drone that couldn't have been more than 500 feet high. So that activity is busy and we're busy out there with them and believe that will continue.

[Martin Malloy:]

Thank you.

[Operator:]

Your next question is a follow-up from Stephen Gengaro of Stifel.

[Stephen Gengaro:]

Thanks. Just a quick one I think for Kyle. Kyle, the deferred revenue from the Kingfisher terminal, is that going to be realized with effectively 100% margin over the next eight quarters?

[Kyle Ramachandran:]

Yes. Stephen, the way to think about is it's recognized over the remaining term of the contract. So you can think about it be recognized ratably over the next two years. So we describe that as about $1 million per month, and it is revenue there than any associated cost with that. It is non-cash as we talked about, but there's current customers including our term customer delivering volumes into that facility. The deferred revenue is related to the $26 million cash payments. So there's additional revenue that will be generated there beyond just that deferred revenue, if that makes sense, and we can follow-up offline.

[Stephen Gengaro:]

Okay. That does make sense. Thank you.

[Operator:]

We have reached the end of the question-and-answer session. I'd now like to turn the call back over to Mr. Bill Zartler, for any final remarks.

[Bill Zartler:]

Thanks, Kelly [ph]. Before we close out the call, I'd like to leave you all with a few final takeaways. Solaris continues to be in a unique position where we can grow with existing and new customers with both our legacy and new products. We are completely reliant on the overall market conditions but we're large enough to be subject to some of them. We built an innovative culture that continue and looks for ways to both improve our product line as well as deploy new complementary products and we continue to have - and additional we've talked about our robust pipeline of ideas and projects that we're working on in conjunction with several of our customers. Our free cash flow generation profile in 2019 provides us with a lot of options on top of our already flexible capital budget and robust balance sheet. We demonstrated our willingness to return capital with shareholders with our recent dividend initiation and we will continue to consider all options that will maximize shareholder return. Thank you all for joining us and we look forward to updating you again next quarter. Kelly, you can close up the call.

[Operator:]

Thank you. The conference is now concluded. Thank you for attending today's presentation. You may disconnect your lines. Have a great day.